How to invest
Making the decision to invest is the easy part: working out where and how to invest your money can be a whole lot harder. For example, which investments do you choose and where do you buy them? How can you be sure you'll make money and achieve your financial goals?
However, it doesn't have to be an uphill challenge. Breaking the process down into more manageable chunks makes it easier to pick the right investments for you. Let Moneywise guide you through the process.
WHAT'S YOUR ATTITUDE TO INVESTMENT RISK?
The first step is to think about risk and exactly how much you can afford to take. You might be a naturally cautious person, worried that you will lose some – or worse all – of your hard-earned cash, or you may be a gung-ho adrenalin junkie happy to put your cash on the line if there is even a sniff of stellar returns. Probably, you fall somewhere between the two.
But before pigeon-holing yourself as a cautious, balanced or aggressive investor you need to think not just about your own personal views around risk – you need to put those into the context of your investment strategy, taking into account what you are trying to achieve and how much time you have before you will next need to get your hands on your money.
HOW TO REDUCE RISK
No investment is without risk - even cash is a risk when you consider how its spending power can be hammered by inflation - however it is possible to control it.
Diversification is one of the best ways to reduce the risk of your portfolio – pile all of your eggs into one risky basket and there's the danger they'll all get smashed.
This can be done by investing in a range of different asset classes of which equities – or stocks and shares – is just one. Each asset class will respond in different ways depending on the economic circumstances, so when one might not be performing so well, another might be faring better. This means your overall returns might not take too much of a hit.
CHOOSING YOUR INVESTMENTS
Once you know what you are investing for, how long you are able to invest and what your risk profile is you are in a much better place to start choosing investments.
You can buy individual stocks and shares in the companies you want to invest in, just as you can go out and buy corporate bonds or property – but for novice investors this can be high risk.
The easiest and cheapest way of investing in these asset classes are via collective funds – the most popular being unit trusts or open-ended investment companies - where your money is pooled with contributions from other investors. A fund manager monitors the markets and decides which investments to buy and sell according to the fund's mandate and risk profile. This provides expertise and economies of scale that you would not be able to achieve yourself.
HOW TO BUY FUNDS
You can buy funds direct from fund managers, but because they don't particularly want to encourage you to buy from them, you will have to pay the full initial charge, which is usually 5% of your investment.
It is cheaper and more convenient to buy from an investment platform – or fund supermarket – as this initial charge will, in the vast majority of cases, be waived.
Platforms sell funds from across the investment universe and allow you to hold your whole portfolio in one place, making it easier to monitor and review. They are not free, however. Which one will offer best value for money for you will depend on how much you have to invest, what other investments you may plan to buy – like shares or investment trusts – and how frequently you'll trade.
HOW MUCH DO I NEED TO INVEST?
You don't need to be wealthy to invest. The majority of funds will either accept minimum lump sum deposits of £500 or £1,000 or they will accept monthly investments – usually from £50.
This means it is easier for investors with larger sums to invest to build a balanced portfolio: £200 a month means you can spread your money across four funds; £300 a month could mean six funds and so on. However that doesn't mean investors with less to invest cannot achieve a decent level of diversification.
Some funds are designed to meet the needs of investors who do not want – or cannot afford – to invest across numerous funds. Mixed asset funds, for example invest across cash, fixed interest (including corporate bonds) and stocks and shares.
Alternatively if you want to be fully invested but have money spread across the world you can go for a global fund - with investments in developed and developing economies.
WHERE SHOULD I INVEST?
If you don't need a 'one stop shop' fund that offers instant diversification you need to think a bit more about where to invest.
UK equities are a popular starting point - we all have a vague idea at least of what is going on in our own economy and are likely to be familiar with many of the companies these funds invest in.
Once you have core holdings in the UK, you may look to invest in other developed markets including Europe and the US. Or if you have a higher appetite for risk you may wish to consider Asia and the emerging markets or Brazil, Russia, India and China, collectively known as the 'Bric' economies.
For ideas for funds across the investment universe check out the Moneywise Fund Awards 2013.
DON'T PAY TAX ON YOUR INVESTMENTS
When you have gone to so much effort to choose the right investments for you, in the cheapest way, the last thing you want to do is give any of your hard-earned returns to the taxman.
Without any planning you could end up paying income tax on some proceeds and capital gains tax when you cash in your investments. But the good news is that the majority of UK investors can shelter all of their investments from tax with a stocks and shares Isa.
If you are saving for your retirement and are confident you won't need your money until then you can get tax relief on contributions by holding your funds in a self-invested personal pension. Both types of 'wrapper' are available from investment platforms.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
An individual employed by an institution to manage an investment fund (unit trust, investment trust, pension fund or hedge fund) to meet pre-determined objectives (usually to generate capital growth or maximise income) in prescribed geographic areas or investment sectors (such as UK smaller companies, technology or commodities). The manager also carries the responsibility for general fund supervision, as well as monitoring the daily trading activity and also developing investment strategies to manage the risk profile of the fund.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
Capital gains tax
If you buy an asset – shares, a second home, arts and antiques – and then sell it at a later date and make a profit, that profit could be subject to CGT. You don’t pay CGT on selling your main home (which is why MPs “flipped” theirs so regularly) or any securities sheltered in an ISA. Individuals get an annual CGT allowance (£10,600 in 2010/2011) but if you have substantial assets it’s worth paying an accountant to sort it for you.
Generic, loosely-defined term for markets in a newly industrialised or Third World country that is in the process of moving from a closed economy to an open market economy while building accountability within the system. The World Bank recognises 28 countries as emerging markets, including Argentina, Brazil, China, Czech Republic, Egypt, India, Israel, Morocco, Russia and Venezuela. Because these countries carry additional political, economic and currency risks, investors in emerging markets should accept volatile returns. There is potential to make large profit at the risk of large losses.
An acronym, which stands for Brazil, Russia, India and China; countries all deemed to be at a similar stage of advanced economic development. The term was coined in 2001 in a report written by Goldman Sachs director Jim O’Neill who speculated that, by 2050, these four economies would be wealthier than most of the current major G7 economic powers.